Accounting - Theses
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ItemDisclosure quality, cost of capital and real effects of disclosure( 2013)This research investigates the link between disclosure and cost of capital in a production-based economy via several stylized models. Specifically, I examine two issues in the presence of ‘real effects’ of disclosure, where the real effects relate to production decisions made by firms. In a production-based economy where there are ‘real effects’ of disclosure, disclosure not only affects investors’ perceptions of a firm, it also (potentially) affects the economic decisions made by firms. My research is aimed at better understanding these effects and how they might flow through to a firm’s cost of capital. The first issue is how the presence of ‘real effects’ relating to disclosure might affect a firm’s cost of capital in the presence of interrelated firms whose future profitabilities are correlated with each other. One key finding is that in a production-based economy, having an interrelated firm is enough to affect the relation between disclosure quality and a disclosing firm’s cost of capital. When disclosure affects firms’ production decisions, disclosure quality has both an informational effect and a production effect on a firm’s cost of capital. Given a positive correlation between two firms, the informational and the production effects invariably affect a disclosing firm’s cost of capital in opposite ways. Moreover, I show that this result is possible even when disclosure does not change the disclosing firm’s own production decisions, and thus does not alter the unconditional distribution of its own cash flows. The second issue is how the presence of ‘real effects’ of disclosure might affect a firm’s cost of capital relating to different time periods, namely the post-disclosure cost of capital (the cost of capital subsequent to disclosure), the pre-disclosure cost of capital (the cost of capital for the period leading up to disclosure) and the overall cost of capital (the cost of capital across both periods). There are three key findings relating to the second issue. First, I demonstrate that, in a production-based economy both the overall cost of capital and the investors’ ex ante welfare can be affected by disclosure quality. As disclosure quality improves, the post-disclosure cost of capital may either increase or decrease, as may the pre-disclosure cost of capital. The change in the post-disclosure cost of capital is not fully offset by the change in the pre-disclosure cost of capital, and therefore the overall cost of capital can either increase or decrease. I also show that as disclosure quality improves, investors’ ex ante welfare can either increase or decrease. Second, I also show that a firm’s profitability of existing and new production are critical factors in determining whether cost of capital increases or decreases in disclosure quality. I characterize conditions under which higher disclosure quality increases or decreases the disclosing firm’s cost of capital over different time periods. Third, I show that when disclosure affects the interrelated firm’s production decision, the disclosing firm’s overall cost of capital changes with disclosure quality, even when the marginal (unconditional) distribution of the disclosing firm’s cash flow is not affected by the disclosure.